World economy: EIU global forecast - Global economy is coming off the boil

The global economy continues to grow at a healthy rate, although the buoyant mood of the last quarter of 2017 has since become more tempered. The US economy will continue to make headway, but the euro zone will lose momentum as pent-up demand fades, and China will resume its long-term slowdown. Moreover, 2018 will also be characterised by tightening monetary policy and credit conditions, increasing risks to global trade and deeper geopolitical concerns in the Middle East. On balance, the global economy is forecast to expand by 3% per year in 2018‑19.

Over the next two years the Federal Reserve (Fed, the US central bank) will continue to raise interest rates regularly, moving away from loose monetary conditions. Other central banks are beginning the same process: the European Central Bank (ECB) will continue to taper its quantitative easing (QE) purchases ahead of a first interest-rate rise in 2020, and the Bank of Japan (BOJ) will also begin to wind down QE, beginning in 2019. Over these two years there will also be monetary tightening in Canada and the UK. Higher borrowing costs in major economies will force other central banks in emerging markets to fall into line. As a result of lower long-term yields through QE, investors have been forced to look elsewhere for attractive returns. This excess liquidity has pushed up the prices of all manner of assets, including bonds, stocks and property, which is a cause for concern.

It should also be stressed that the effects on financial markets of withdrawing huge amounts of monetary stimulus are not well understood. The Fed is doing its bit to minimise the disruption by outlining how it will taper its QE programme. The ECB and the BOJ are likely to use the same strategy, but the impact on financial markets remains unclear.

Since the start of 2018 trade policy has become the biggest risk to our central forecast for global economic growth. The US president, Donald Trump, is shifting his country's previous qualified support for free trade in a protectionist direction. After import tariffs on steel and aluminium were imposed in March, the US government threatened China with tariffs on imports worth about US$50bn a year in April. China responded with its own, equivalent, list. The Economist Intelligence Unit expects negotiations to result in some of the threatened tariffs being dropped, but others will still be imposed in mid‑2018. In this scenario, we would not expect a major slowdown in growth. However, we note the downside risk posed by rounds of escalating tariffs and non-tariff barriers that would affect business confidence, investment decisions, diplomatic ties and, ultimately, the performance of the global economy. A new wave of protectionism would also make it harder for the world to respond to the next global downturn, to the extent that tariffs would erode consumer spending power.

Developed world

The North American economies of the US and Canada are in fine shape. Excess supply in their labour markets is enabling firms to hire large numbers of new workers; larger workforces are boosting consumer spending; and rising private consumption is encouraging firms to invest and hire more workers. However, we expect this phase of the business cycle to turn in 2020, when the Fed will signal the need for a faster pace of interest-rate increases. This indication will tip the economy into a mild recession early in the year. Our core forecast is that the dip will be shallow and the rebound relatively rapid, owing to the Fed cutting interest rates aggressively in response. This means that the recovery in 2021‑22 will be brisk.

In the euro zone, country-level disparities persist, but almost all member states have registered firmer rates of economic growth over the past 18 months. We believe that the economic recovery has further to run, partly because it is rooted in fundamental factors such as rising employment. Nevertheless, we expect growth in the euro zone to moderate in 2018, to 2.2%, from 2.5% in 2017. Furthermore, the longer-term outlook for the euro zone will remain challenging. Demographic factors will begin to exert a more powerful drag on an increasing number of countries in the bloc. We do not expect policymakers to make major progress on further integration of the economic and monetary union, owing largely to Germany's hard line on risk-sharing.

In Japan, the prime minister, Shinzo Abe, will continue to pursue his eponymous economic agenda, Abenomics, focused on reflating the economy. Although the economy faces significant constraints on growth from an ageing and shrinking workforce, Abenomics has contributed to a mild recovery that has, until 2017, spanned six years. Japan now finds itself boasting a positive output gap, with actual output exceeding the economy's potential. We expect this trend to continue in 2018‑22, with real GDP growth averaging 1.2% a year.

Emerging markets

We expect conditions for emerging markets to become more challenging in the first half of the forecast period as US interest rates continue to rise. India will be Asia's fastest-growing large economy in 2018‑22, expanding at an average annual rate of 7.7%. Growth will also remain on track in the Association of South-East Asian Nations (ASEAN) member states, with an average annual expansion of 4.8%. We expect the Chinese economy to slow slightly in 2018, to 6.4%, from 6.9% in 2017. Growth in the region will be supported by relatively stable governments. However, the nuclearisation of North Korea continues to heighten security and political risk, especially as the US administration has not shown a clear strategy towards North Korea. Therefore, we are sceptical about whether diplomatic efforts—such as the upcoming talks between the two Koreas, followed by a potential meeting between Mr Trump and Kim Jong‑un—will lead to meaningful progress.

The ongoing recovery in Latin America is forecast to gather momentum in 2018‑19, after several years dominated by macroeconomic policy adjustments related to the end of the commodities boom of the previous decade. Sustained Chinese growth will provide a favourable external environment for the region, particularly for commodity exporters, such as Brazil and Argentina. Combined with a rise in global risk appetite, as reflected in lower sovereign credit default swap rates (except for Venezuela, which defaulted on some external debt obligations in November 2017, taking the country further into economic and financial crisis), the major stockmarkets had been bullish until the recent turbulence experienced by markets around the world. On aggregate, we expect growth in Latin America to average a modest 2.5% a year in 2018‑22.

Prospects for rapid economic growth in the Middle East and North Africa remain stifled by heightened geopolitical risk, macroeconomic imbalances, policy uncertainty and corruption. At present seven countries in the Middle East, which collectively account for a quarter of the regional population, are either riven by civil war or destabilised by Shia-Sunni rivalry. Geopolitical risk has also risen rapidly within the Gulf Co‑operation Council (GCC). We expect the boycott of Qatar by some of the GCC countries and Egypt to continue until at least 2021. Both sides will remain willing to absorb some economic pain rather than back down. Moreover, the Trump administration has taken a hawkish turn of late with the appointment of John Bolton as national security adviser; this reduces the chances of a diplomatic resolution in the short term. Taken together, we forecast that real GDP growth in the Middle East and North Africa will pick up to an annual average of 3.1% in 2018‑19, followed by 3.8% in 2020‑22, driven largely by higher investment in Egypt and Iran and government spending in the GCC economies.

Following a dismal performance in Sub-Saharan Africa over 2016‑17, we expect a lacklustre recovery to take hold from 2018. This will be driven by a favourable external environment as export prices strengthen and trade gathers pace. However, policy mismanagement, unsupportive political dynamics and a gradual tightening of credit conditions in developed economies will weigh on future prospects. We therefore expect growth to remain fairly subdued in 2018‑19, at 2.9% each year. Prospects in the second half of the forecast period are brighter.

Exchange rates

The US dollar has remained weak in early 2018, in spite of solid economic data and signs that the Fed will remain committed to monetary tightening. In large part, the dollar's poor performance over the past year reflects the comparative maturity of the US business cycle. Tightening by the Fed should provide the dollar with fresh support over the next two years, but any rally in 2018‑19 will be modest at most. Among G10 currencies, the euro made the biggest gains against the dollar in 2017 as economic data went from strength to strength and some political risk receded. Currency markets have taken the Italian election result in their stride. However, the election will make further institutional reform in the EU more challenging, and we remain sceptical about whether the euro zone economy can maintain its recent momentum. The yen is expected to appreciate further against the US dollar in 2018‑19 owing to its safe-haven appeal, supported by a large current-account surplus, and as the BOJ slows the pace of its asset purchases.

Commodities

We forecast that global oil prices will remain largely range-bound at US$60‑70/barrel in 2018‑19 as OPEC supply restraint and tensions in the Middle East are partially offset by rising oil production from non-OPEC producers, mainly shale oil in the US, and concerns regarding global trade. Since mid-March speculation that the US would withdraw from the Iranian nuclear deal, together with the prospect of disruption to oil production from a broadening war in Syria, has pushed dated Brent Blend prices above US$70/b—the highest level since November 2014. Industrial raw materials prices are set to rise for a second successive year in 2018 on the back of strong demand growth in emerging Asia and occasional supply tightness. We expect food, feedstuffs and beverages prices to be sluggish, reflecting subdued demand and record-high inventories following a few bumper harvests, particularly in the 2016/17 season for grains. However, the announcement of proposed tariffs by the US and China, and crop disruptions related to a La Niña weather event pose risks and add volatility to our forecasts.